Tuesday, April 21, 2020

Energy Stocks Are Still Overpriced

Green curve above shows the WTI oil futures curve at the market peak on February 19th, orange curve shows what it looks like today.

Ignoring the debacle in the front month (May and June) contracts, the July oil is trading for $20/bbl which is down 66% from the 2019 year-end price of $59/bbl. The out-year contracts are now converging on $40 which is down by 33% from the 2019 year-end price.

Meanwhile, Exxon is down 40% year-to-date and the XOP fund is down by about half. The equities have fallen by slightly more than the commodity price, but there are two problems with that:
  1. Equities should fall by more than the commodity price because of operating and financial leverage
  2. Energy stocks were overpriced to begin with
The leverage should be obvious. If your oil costs $15 per barrel to produce, a price decline from $60 to $40 (-33%) lowers your profit per barrel from $45 to $25, a 45% decline. Having debt also leverages the enterprise value decline impact on the equity. 

I have been watching Exxon for years trying to justify owning it. My clients would be a lot happier owning a "blue chip" selling dinosaur juice than sitting in T-bills. Here are my notes from June 2016:
They had net income of $1.8 billion in the first quarter. The upstream lost a little bit of money, but downstream and chemical made money. If you value those two segments at 15x Q1 annualized net income, they're worth $135 billion. (That would be in the top few dozen of the S&P 500.) The enterprise value of XOM is $400 billion, so you're paying $265 billion for the oil and gas reserves. The PV-10 was $208 billion at the end of 2014, down to $71 billion at the end of 2015.

Can also think in terms of a very attractive price to pay for XOM. Let's say $135B for the two segments and then $100B for the oil. That's $235B EV, which is $165B less than current EV. Means 45% lower stock price - $40. 
The stock was trading at $90 then and now it's at... $40. Oil was at $50 then, now the weighted average from a DCF valuation would be in the high $30s. Again, that 20% commodity price decline should be magnified by the operating and financial leverage into an even bigger share price decline.

This pattern exists at every energy company I have looked at recently. At least Exxon makes money - so many companies in the industry do not, and did not even at higher prices. Last fall I asked, "What happens to oil prices when producers have to be profitable?" One reason I have had to hide out in cash this cycle is that when people are too optimistic (delusional), no one can make money investing. Either the business operators are overfunded and compete all the profits away (energy, startup sector, "disruptors," Netflix, Amazon) or investors are too optimistic and pay prices for share interests that almost guarantee losses. The willingness to pay high multiples for hypothetical future earnings is an extreme example of double counting. (The Nifty 50 were expensive but they all made money.)

The most popular stock on retail brokerage (bucket shop?) Robinhood during the historic oil futures decline to negative prices this week was the United States Oil Fund ETF. What they don't seem to realize is that USO is not a tank farm full of cheap oil that is going to bounce back in value. It is just an entity that buys front month oil futures contracts and rolls them over. It is getting chewed up by the contango (having to sell the future low and buy a higher priced one to roll over) and will probably go to zero this summer.

This bear market should give a final washout of the energy sector. There will be lots of bankruptcies with equity wipeouts and very low creditor recoveries. As long as the profitability-indifferent investors are scared away, the survivors would be able to consolidate the remaining properties, develop them rationally, and make money.


Stagflationary Mark said...

NOVEMBER 6, 2009
Illusion of Prosperity: Financial Innovation Meets Oil Investing

Zero-sum games are not known for their ability to keep up with inflation long-term. Unlike investing in general, for each winner in derivatives there MUST also be a loser. There is no rising inflationary tide that can lift all boats.

That said, USO investors managed to go that extra mile. They actually managed to lose a lot of money betting on the rising tide of oil and being right. Apparently the "losers" on the other side of the trade wanted to be paid a hefty premium to take the losing bet.

USO is the retail investor gift that just keeps on giving, lol. Sigh.

As for oil itself, glad I haven’t been charting the oil to gold ratio. It would have been really annoying when it went to infinity. Spreadsheets have a hard time scaling that.

You get bonus points for questioning hyperinflation lately. Your timing was excellent. I’m fairly confident, at least in the short-term, that oil trading at negative $40 per barrel isn’t something that was predicted in the Shadowstats 2008 Hyperinflation Special Report. Granted, I did not actual read it. I never paid for the subscription. ;)

CP said...


There's been significant inflation in things (assets and commodities) that rich people buy because they think they will protect them from inflation, but flat prices - even falling prices - in things that people buy to consume.

Stagflationary Mark said...

Correction: I meant to say gold to oil ratio. It’s oil at zero in the denominator that takes it to infinity.

CP said...

Many investors feel that a surfeit of bargains has already emerged in the downturn, and they are busily deploying capital into these (perceived) bargain stocks and bonds.We certainly observe the price concessions, as well as the kind of illiquidity that enhances the ability of buyers to buy at what they consider to be sufficient discounts. But here is one measure of “value” which is pretty sobering: The price/sales ratio of the S&P 500 at the end of September 2007 was 1.64. At the end of March 2009,it was 0.82. At the end of March 2020,it was 1.86, down from 2.32 at the end of December 2019!
- Paul Singer

Glenn said...

Perhaps the oil majors are just like the gold miners- they constantly destroy value and underperform their commodity. And this continues despite the industry bottoming out. Investors never fire the management teams (or their brokers) and rescue the good part of these stocks.

The oil majors make their money on midstream and refining. Then they punt it all away on the E&P side, e.g. buying acreage from Aubrey Mcclendon, paying takeover premiums for assets, buying Interoil, etc. etc.

Allan Folz said...

My clients would be a lot happier owning a "blue chip" selling dinosaur juice than sitting in T-bills.

Can confirm.

Millennials have their Achilles Heel ("compounders" that are gonna flip the switch on profits any day now), and Boomers have theirs (divvy yields funded by bond issuance).

Stagflationary Mark said...


But here is one measure of “value” which is pretty sobering...

That data is very sobering.

Here’s another sobering statistic. How many people have caught this virus in a restaurant? Does anyone really have any idea? There’s too many sick and not enough testing. Here’s something we do know though. Hepatitis A is a virus. Even in a coronavirus pandemic, it’s still being transmitted. It’s still being tracked. The probable sources are still being found. Just can’t say the same for the virus that has most of the country locked down. Sigh.

Hepatitis A associated with Señor Moose restaurant in Seattle

Content in cash. No hurry to put it back to work. There was $118 trillion in US net worth at the end of 2019. The Fed acted decisively and oil still hit negative $40 per barrel. How shocked and awed am I really suppose to be?

viennacapitalist said...

here in Austria there is small cap oil servicer SBO that provides high Quality pipes to US shale. Although they are down 70 percent from 2018 highs, it still trades at EV multiple of 11 based on last year's EBIT (which will never be reached again?)

CP said...

Mark, here's a new genre of chart for you. Check out Exxon share price divided by WTI oil:


CP said...

I should have shorted XOM back in 2016. Those notes were a short writeup, basically saying, "there's no way this is an attractive buy even under strained assumptions."

Here's how it performed versus the S&P subsequently:


Did the same thing with Scheid (SVIN):


Stock fell 60% after that.

Stagflationary Mark said...


I think the Alcoa share price divided by the aluminum price on a chart would highlight some risks.

Aluminum prices are down about 18% year to date.
Alcoa’s stock price is down about 65% year to date.

Planes are made of aluminum (747-400 has 147,000 pounds of aluminum) and burn oil. Mining aluminum burns oil. Making fewer planes uses less aluminum and therefore less oil. Flying less burns less oil. There are certainly a lot of connections to think about. How many retail investors are thinking them all through? Will people fly and drive as much as they once did? Or are most just going to buy the dip and not worry about it? Hmm.

CP said...

Woah... Alcoa is back to the 1982 low?


Although that's tricky, because in 2016 an "old Alcoa" split into two by spinning off this new Alcoa and renaming itself Arconic.

Still, the enterprise value is down to $2.4 billion. The ttm EBITDA was $1.5 billion.

Their pension plan has $5 billion of assets against $6.5 billion of obligations.

NingCheng said...

Not an expert in terms of oil prices vs. stock price, but most of these companies who have great exposures would hedge their productions to some extent I'm assuming. That could probably explain.

Stagflationary Mark said...

USCF Announces One-for-Eight Reverse Share Split for the United States Oil Fund (NYSE Arca: USO)

Despair.com: Persistence

CP said...

Stagflationary Mark!:


Anonymous said...

Take a look at WLL today. They can't get enough of the equity!

CP said...

Whiting Petroleum Corporation, et al.
Case Number: 20-32021 (DRJ)
Southern District of Texas

On April 1, 2020 (the "Petition Date"), Whiting Petroleum Corporation and four affiliated debtors (together, the "Debtors") filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code. The Debtors' bankruptcy cases are jointly administered under case no. 20-32021 and are pending before the Honorable David R. Jones in the United States Bankruptcy Court for the Southern District of Texas.


CP said...

By the way, I've never heard of Stretto. How did Prime Clerk lose this piece of business?

("Prime Clerk is the global leader in complex business services and claims administration and a division of Duff & Phelps.")



noun: stretto; plural noun: stretti

a passage, especially at the end of an aria or movement, to be performed in quicker time.
a section at the end of a fugue in which successive introductions of the theme follow at shorter intervals than before, increasing the sense of excitement.

adverb: stretto

(as a direction) in quicker time.

Stagflationary Mark said...


Here’s a review of an Illusions of Prosperity book that’s amusing to me. (Not my book.)

Reviewed in the United States on August 19, 2000
A Very Disappointing Book

Essential to Blau's case for greater government intervention and more "economic democracy" is his factual claim that recent prosperity is an illusion, save for all but the richest Americans.


1. This 1-star review was written in 2000 (just as the bubble was starting to pop).
2. The Illusions of Prosperity book was published in 1999 (just before the bubble popped).
3. My Illusion of Prosperity blog started in 2007 (just before the bubble popped).
4. The world’s richest man (Jeff Bezos), an American, recently became even richer as unemployment is spiking higher.
5. Once the world’s richest man fully automates all his warehouses, he’ll most likely become even richer.
6. There’s nothing quite like a global pandemic to accelerate the advancement of automated warehouse technology. (Robots never call in sick.)

CP said...

Donald Joseph Boudreaux (born September 10, 1958) is an American economist, author, professor, and co-director of the Program on the American Economy and Globalization at the Mercatus Center at George Mason University in Fairfax, Virginia.

Imagine being a Professor of Globalization. Not a good look.

Stagflationary Mark said...


Imagine being a Professor of Globalization. Not a good look.

Many would have assumed that investing time in researching an Amazon reviewer would have been a total loss, myself included. You struck proverbial pay dirt though.

Not a good look, indeed. Ha!

Allan Folz said...

LOL. "his factual claim" was the tell, amirite? Normal people never talk that way.

Is there some sort of CCP troll I'm missing where declaring bankruptcy leads to spiking the equity 5-10x? Is it one of those things where Q translates into a lucky number in China? WTF!

Stagflationary Mark said...


LOL. "his factual claim" was the tell, amirite? Normal people never talk that way.

Normal people also never conclude a conversation with talk of death marches when they’re trying to convince you that things are not as bad as they seem. Amirite?

I bring it up because:

April 20, 2020
CNBC: This oil price crash isn’t as bad as it seems — here’s why

That said, he noted that as the subsequent contracts reach expiration, they could engage in their own “death march down towards the super-low cash prices.”

It’s the last paragraph of the article!

I never did mind about the little things...

Just smile and say, “I never did mind about the little death marches.” ;)

CP said...

Mark, I had to go back to the Archives and dig up some of our convos from years ago since inflationism is trying to make a comeback.

I figured out the error that inflationists are making. They think that since the central bank can print any amount of money, it can cause inflation, i.e. an increase in the price index. That part is technically true. But what they actually want is something much more specific than "inflation": a gentle, restrained, gradual increase in prices that is basically even across all categories. House prices, waiters' tips, silver, oil, paper towels all going up 2% a year. Unfortunately, that doesn't seem to be possible, here or in Japan. At the first sign of easing (a Hilsenrath article in the WSJ) people bid up speculative assets. But nobody bids up the amount that truck drivers are paid per mile. Nobody bids up the hourly wage of Best Buy employees. They can have inflation but it's lumpy and shows up in the least desired places. True, you get construction bubbles (horrifically wasteful but "job creating") but you also choke off probably just as much legitimate economic activity through higher commodity costs and energy prices. You could print so much money that an ounce of silver goes to $1,000 before the average low skilled wage would increase 50%. Central bankers gradually discover this. They "taper" and try to figure out what's next.

Remember first and second level thinking. First level thinking is that loose monetary policy leads to inflation so buy metals and stocks and short bonds. The second level thought is that loose monetary policy leads to some goods increasing in price, mostly the hoard-able primary inputs like energy and base metals. Much of the causation is psychological. The input price increase squeezes producers who can't raise their prices as much to compensate for rising input costs. Maybe they even go out of business or layoff workers. Overall, society is poorer thanks to the misallocation of resources. Also, fear of loose monetary policy causes investors to sell bonds and interest rates rise. Both the rising input costs and rising interest rates choke off the economy; the inflationary policy is self-limiting because of the damage it does.

The BOJ has printed oodles of yen since their demographic collapse started - 4x increase in monetary base since 1990. As Cornelius Vanderbilt would say, "that amounts to nothing." The Nikkei fell 65% anyway during the same time period (75% peak to trough), and - best part - their 10 year bond yield has fallen to 60 bps. Their 30 year yields 1.6%. Further, the Japanese price index has not changed in 20 years. On a long term view, Japanese CPI increases seem to have stopped right around the time that serious yen printing started. The "increased monetary base causes increased CPI" thesis has sprung a leak, and the inflationists are out of buckets. Clearly there is a different, lurking variable. In fact, an increase in monetary base and a fall in the inflation rate both look like dependent variables of population!

CP said...

And from your blog comments:

My current take on inflation is that basket of goods the Fed considers for inflation calculations simply can't inflate due to demographics, credit saturation (all credible future promises have been extracted from the willing) and wealth inequalities. What's interesting about the current dynamic is that wealthy people can (as a group) create inflation in specific areas on a whim. Since 2008 we've had massive runups in oil, gold, farmland, agricultural products, prime real estate (e.g. Hamptons or London), famous artwork, digital currencies, etc. Inflation in many of these asset classes is completely benign, but when speculative interest centers on something used in the real economy (e.g. oil) the effects are catastrophic. So, I think we might be stuck in a weird situation where attempts to acquire claims against the future by buying things most people consume quickly blow up because the natural consumers of those things are completely tapped out. OTOH, while inflation in the remaining asset classes is relatively benign, there's no fundamental support for a particular price level so there's always a fear that the current fad will end.

Allan Folz said...

"Kuppy" said something interesting on the Teslacharts podcast this week. He said revolutions happen when the 1% gets upset with the 0.1%.

This I think is an under-appreciated fact. Revolutions take organization and that takes big money. The 90% ain't got any. The 10% ain't risking the little bit they do got because they know a lot of life is luck and "but for the grace of God go they."

But the 1%... they are wont to convince themselves they are self-made men who's genius and hard-work brought them all of their success. If they did it once, they can do it again.

If there's deflation in what the 1% is invested in, no big change for the bottom 99%, and more 10X growth for the 0.1%... I dunno, maybe the 1% starts getting ideas in their head.

Not saying it's going to happen, but it is interesting to consider. I bring it up because it could happen and not necessarily be in conflict with the no hyper-inflation in consumer goods posited in the comments.

PS. Kind of funny mentioning digital currencies in the list of massive run-ups in 2014... if only we knew then what we know now, eh.

Stagflationary Mark said...


Just before reading this, I purchased I-Bonds and EE-Bonds for the year. Wanted to get the purchases in before rates reset on May 1st. The former are tied to the inflation rate but cannot deflate. The latter double in value if held a full 20 years (effective 3.53% annual interest rate). No greater fool ever needed.

I will now share part of an email that I recently sent a friend. We were discussing the Fed.

So, yeah. It is a delicate balance. I say that they will err on the side of sliding into Japan’s situation instead of Zimbabwe’s situation. Japan has clearly shown that as dire as it always looks, it has still been manageable. At least so far, they never really lost control. Zimbabwe’s situation is the immediate end of America as we know it. Lesser evil thinking. Delay and postpone. That’s the only end game there is now.

The Fed cannot risk any resemblance to the 1970s repeating from here on out, because the next time we will probably never pull out if it. It was so hard the first time.

The Fed can risk ZIRP and Japan level deflation though. They will stay in control. I’m thinking best case for them, given current conditions, is 0% inflation with 0% interest rates. Gives the Fed temporary infinite power to protect the banking system. There’s no way out of the trap. It will obviously fail someday. But perhaps after I’m dead.

Real yields too low and toilet paper won’t be the only thing people are hoarding. Too high and the economy implodes. That’s why I’m betting on 0%. Is it a coincidence that Japan ended there for both inflation and interest rates? Maybe not! Lesser of all evils I’m thinking.

And lastly, remember that long-term fed funds rate chart I did? It was an exponential decay chart that ends at 0%. Well, it’s happening again. We’re right back on trend. There may come a time, like Japan, when a quarter point increase in the fed funds rate is thought of as draconian. And back down to zero we will go.

Just theories. If I knew everything, then I wouldn’t have called myself Stagflationary Mark, lol.

Glad I backed up the truck on long-term TIPS quite a few years ago, back when I was told there was a bond bubble. The ones that mature in 2040 and 2041 are still paying me 2.13% over inflation. I should probably sell them to those now settling for negative yields, but I already cashed out the one TIPS bond filling my retirement account. That’s all cash now and it’s patiently waiting for fairly low risk long-term opportunity. I’m reasonably content.

If the Fed intended to shock and awe me into taking serious risk, they have failed miserably. I have never been this content in cash. I saw two different predictions for oil this week. One was negative $100 (short-term);and the other was positive $100 (longer-term). Feels like a casino and far too obvious, like nice round numbers are just being pulled out of a hat for many retail investors to choke on.

The Fed could easily get us to hyperinflation if the banking system truly wanted that. All they would need to do is announce a $180+ trillion program to protect America’s $180+ trillion pre-crisis net worth. The Fed most certainly does not want that though. Instead, they offer a much, much smaller program with intent to shock and awe us into believing they will toss unlimited amounts of money from helicopters.

Stagflationary Mark said...

As economic growth recovers and real rates rise, the price of Tips will fall leaving Tips investors with large losses in the face of accelerating inflation. - Jeremy Siegel, February 2, 2011

This is my favorite quotes of his. It’s been a recurring theme on my blog.

30-year TIPS real yield then: 2.10%
30-year TIPS real yield now: -0.19%

Thankfully, was never a believer in the economic growth will drive real rates higher theory. Never experienced the large losses. Far from it. That theory only makes sense if the prosperity isn’t illusionary and the economy can therefore tolerate higher real yields without imploding.

Was also never a believer in the Treasury Inflation Protected Securities (TIPS) would leave me with large losses in the face of accelerating inflation theory, either. Maybe it’s because those bonds would be inflation protected in the face of accelerating inflation. Go figure. Fortunately, never really had to test that theory. Inflation never really did accelerate.

2.10% was a gift for risk-averse long-term investors, and I wish to thank Jeremy Siegel and his mindset for helping to make it possible. Locking in an acceptable real yield with intent to hold to maturity never caused me to lose much sleep. Unfortunately, those days are over. Now we can all lose sleep together. Those of us paying attention, anyway.

CP said...

Uh oh:

If you think too much money creation causes inflation, we will get inflation. If you think budget deficits cause inflation, we will get inflation. If you are old-fashioned enough to think that rising costs and increasing economic inefficiency cause inflation, we will get inflation. It really doesn’t matter which economic theory you subscribe to, they all arrive at the same destination — more inflation.

CP said...

Update on Japan CPI:


It's up about 2% - total - over the past 20 years.

Meanwhile their central bank balance sheet has expanded 6x:


Japanese stocks flat over that time period:


Their 10 year bond has occasional positive yields now:


What I said in 2014:

On a long term view, Japanese CPI increases seem to have stopped right around the time that serious yen printing started. The "increased monetary base causes increased CPI" thesis has sprung a leak, and the inflationists are out of buckets. Clearly there is a different, lurking variable. In fact, an increase in monetary base and a fall in the inflation rate both look like dependent variables of population!

Stagflationary Mark said...

1973 Gasoline Station Sign

Red Flag: Closed. No gas.
Yellow Flag: Commercial Trucks and Cars Only
Green Flag: Everyone Welcome

2020 needs a white flag.

CP said...

Here's what Horizon Kinetics had to say this month about the suspicious lack of inflation:

A second factor was that the massive Fed spending during the Credit Crisis was directed to the financial institutions that were the center of the crisis, to help them deleverage their balance sheets. The money stayed largely within the finance sector and was not transmitted to the broader consumer economy.[Oops!]

A third factor was the Consumer Price Index itself. Those figures are highly suspect and we believe that they understated the rate of inflation. The methodology has been revised periodically, and each such change seemed to lower the reported rate. The transparent measure of inflation is the money supply, and that had been rising not at the 2% CPI rate, but at 6%.

Of course, my Chipotle burrito and postage stamp indices are saying 2% compounded, almost exactly.

Seriously, I think HK are making a mistake by equating inflation with the money supply increase. Look at what happened in Japan: huge increase, no inflation.

HK also talks about their investment in Franco Nevada, a precious metals financier via royalties and "streams". (A stream means that FNV buys product from the miner at a fixed price per ounce.)

Market cap of FNV is $23 billion, revenue last year only $844 million (27x sales). Yes, it is high margin revenue because they are a royalty owner, but it is telling that HK does not talk about valuation. Ignoring depletion, FNV still had $145 million cost of revenue last year, bringing income down to $700 million. So, FNV has a 3% earnings yield. (Annual report: https://www.sec.gov/Archives/edgar/data/1456346/000155837020002894/fnv-20191231ex992d5a50e.htm)

HK will probably argue, "a 3% real yield! That's way better than Stagflationary Mark's TIPS."

But "real" goes both ways. The price of gold may not go up. Gold is expensive (selling for much more than mining cost), gold miners are expensive, and the supply of gold will be increasing because the spread over mining cost is wide and there's cheap capital to exploit it.

CP said...

* meant $145 million of cost last year, bringing income down to $700 million

And it's not really fair to ignore depletion and depreciation. The way the streaming and royalty business works is that FNV gives the miners cash up front in exchange for royalties or streams once the mine is in production.

It's a true cost of business, it was just spent in advance (far in advance) of receiving revenue.

And as we saw with Netflix this week, there is a strong risk that the depletion is understated, because of over-estimates of mine production.

Anonymous said...

I agree CP, Horizon Kinetics seems to be making an argument for gold and oil after they had positions, I defer to Lacy Hunt, low rates for as far as the eye can see.

Allan Folz said...

What's weird is I can't tell new comments from copy and pasted comments from 10 years ago.

CP said...

What's weird is I can't tell new comments from copy and pasted comments from 10 years ago.

Time is broken. It's why this bubble has lasted so long and why the Trump election was completely meaningless.

Allan Folz said...

Too many olds.

CP said...

New post for comments: http://www.creditbubblestocks.com/2020/04/stagflationary-mark-on-inflation.html

CP said...

BTW, the only comment thread that was ever longer than this one?


CP said...

XOM and XOP both been moving back down towards the March lows:



CP said...

Also, reminder:

"Real" goes both ways. The price of gold may not go up. Gold is expensive (selling for much more than mining cost), gold miners are expensive (very low earnings yields), and the supply of gold will be increasing because the spread over mining cost is wide and there's cheap capital to exploit it.

CP said...

Back up to 79 hours of work to buy one ounce of gold: